Meghnad Desai, Chairman, Advisory Board · to what Greece went through last year with its dual elections. Greece rejected holding a referendum on the euro, and ended up electing a

1March 2013

OMFIFOfficial Monetary and Financial Institutions Forum

OMFIF BulletInGlobal Insight on Official Monetary and Financial Institutions

March 2013

Markets may love Mario Monti. Italians, evidently, do not. The low

Italian election score for the caretaker prime minister, and the substantial support for anti-euro populists, lays bare a fragmented polity in Rome without a clear view on getting Italy – and Europe – out of its mess.

Most of us believe that that economics ultimately shapes politics. But, well beyond Italy, politics is taking a lead role in creating economic shocks. The result, across the world, is gridlock.

The economic crisis is deeper than anyone anticipated. Structural

deterioration in western capitalism is now exposed, after years of neglecting manufacturing and false hopes that services would replace industry.

The western economies may yet be able to get by with some inflation, exchange rate manipulation and delay in recovery. This muddling through could be largely peaceful. Yet there’s no guarantee. We may face serial recessions of unknown depth, with further fracturing of politics.

The Italian imbroglio is not dissimilar to what Greece went through last year with its dual elections. Greece rejected

holding a referendum on the euro, and ended up electing a government which is taking the punishment despite its unpalatability.

Italians may do the same with a Grand Coalition of Socialists and the party of ex-prime minister Silvio Berlusconi, or with the Socialists in charge, replying on the dubious support of the ‘Grillini’ of Beppo Grilli’s 5 Star Movement. But the Grillini may prefer the response Iceland had to its debts: Can’t pay, Won’t pay. That would mean either another election or exit from the euro, possibly both.

Rome’s mess extends beyond Italy Political gridlock as western capitalism faltersMeghnad Desai, Chairman, Advisory Board

(continued on page 8...)

Tale of two QEs in UK and US as Osborne faces pressure Darrell Delamaide (left) analyses different approaches for quantitative easing (QE) at the Bank of England and Federal Reserve. William Keegan (right) ponders on the longevity of UK chancellor George Osborne in the light of Britain’s sluggish economy, warning that prime minister David Cameron could seek to to follow the example of his predecessor 50 years ago, Harold Macmillan. See ARtICleS On P. 3 AnD P. 28.

Shinzo Abe, the Japanese prime minister, has surpassed expectations by opting for Haruhiko Kuroda, the most

qualified candidate, as the next Bank of Japan (BoJ) governor.

By choosing Kuroda – a former senior finance ministry official and up to 18 March president of the Asian Development Bank (ADB) – over other front-runners such as former BoJ deputy governor Kazumasa Iwata, Abe will bring a hitherto sadly-missed spirit of innovation into the Japanese central bank.

In some ways, Iwata would have been a safer choice, a mainstream candidate who would have been accepted without problem by Japan’s opposition parties. But Iwata became untenable after the latest meeting of the Group of 20 economies came out against efforts to lower currency values through purchases of foreign bonds, a step favoured by Iwata. See ‘tHe GuBeRnAtORIAl DIFFeRenCe’, P. 4-5

Shumpei Takemori, Advisory Board

Innovation at BoJAbe’s governor

(continued on page 8...)

ContentsA tale of two QEs Darrell Delamaide 3

The gubernatorial difference Gabriel Stein 4QE debate picks up steam Darrell Delamaide 6

Back to banking basics Moorad Choudhry 9

Solidity through detachment Patrick Honohan 10Japan leads the way Trevor Greetham 12German economy looks east Michael Holstein 13Support for trade link Bruce Stokes 15Cameron’s European gamble Philippe de Schoutheete 17European trade trends DZ Bank Group 18Politics again the focus DZ Bank Group 21Dark hints from dollar dance Michael Howell 22UK needs borrowing U-turn William Keegan 28

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letter from the chairman

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One of the phrases that 20 years ago helped propel Bill Clinton to the US presidency against George H. W. Bush was ‘It’s the economy, stupid.’ In the economically

sombre days of 2013, substitute the word ‘politics’ and you sum up a central reason why, fully five years after the transatlantic financial crisis, the world economy, despite greater optimism in different ways in the US, China and Japan, remains becalmed.

The influence of politics, too, provides at least a partial explanation for the apparent dislocation between the rude good health of financial markets all over the globe, particularly for equities, and the still sluggish state of the real economy, in particular in Europe. Political gridlock, magisterially explained by Meghnad Desai as pervading countries from Italy to India, appears to have persuaded central bankers that they must make up the difference by flooding markets with streams of easy money.

Yet this equilibrium is plainly unsustainable. Sooner or later, the fragile state of politics in many parts of the world must either give way to a new phase of stabilisation or will tip over into destabilising the underlying economics. This is one reason why this year’s continuing stock market surge comes with a distinct health warning.

For the time being, a prime reason for buoyancy on world markets is plainly the new dynamism in the Japanese economy aimed for by prime minister Shinzo Abe. Shumpei Takemori explains why he expects Haruhiko Kuroda as the next Bank of Japan governor, who over the past month forged ahead of other candidates such as Kazumasa Iwata, will bring a new spirit of innovation into the Japanese central bank.

In addition to his monthly round-up of Fed developments, Darrell Delamaide looks at contrasts and similarities between the quantitative easing introduced in the US and UK. He concludes that the Fed’s practices appear more convincing than those of the Bank of England. Both central banks are getting ready for change at the top, an issue dissected by Gabriel Stein, who concludes that, despite the collective leadership of many central banks, the personalities at the helm really do make a difference.

In Europe, despite the setback of the Italian elections, the move towards greater integration is proceeding apace. Philippe de Schoutheete calls UK prime minister David Cameron’s reaction of calling for a British referendum on EU membership ‘a hazardous gamble’ – and says the EU can make its way in the world without the UK. Patrick Honohan records five reasons why he’s hopeful about the consequences of the planned move towards banking union in Europe. Germany, meanwhile, is moving away from Europe, at least as far as foreign trade is concerned. In an article accompanying DZ’s Bank’s regular round-up of EU trade trends, Michael Holstein explains how Germany’s foreign trade is undergoing deep and, it seems, unstoppable change. But there is some good news. Bruce Stokes reports that Pew Research points to impressive public support in both the US and Europe for the planned transatlantic trade and investment partnership.

On wider financial markets, Michael Howell explores how flow of funds data point to a worrying imbalance between a build-up of dollar demand and a shortage of private sector dollar holdings. Trevor Greetham analyses continued bullish behaviour on markets with particular reference to Japan. Moorad Choudhry outlines what he calls the ‘back to basics’ approach to funding risk for banks. William Keegan surveys the storm clouds above the British economy, and wonders what they portend for the future of George Osborne, Britain’s confident-sounding but embattled chancellor. y

It’s politics, stupid

David Marsh, Chairman

Dislocation of financial markets

Official Monetary and Financial Institutions Forum

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Compared with Fed, BoE looks behind the curveDarrell Delamaide, Board of Contributing Editors

A tale of two Qes

The US Federal Reserve appears to be talking a better game than the Bank of England when it comes to quantitative easing.

Nervous currency markets tend to react to any hint about the future and lately have decided to devalue the pound amid expectations that the BoE will restart its programme of asset purchases.

It’s hard to know in this environment whether the dollar is actually stronger or it is just that the pound and euro are weak. The irony is that the Fed is making noises about ‘tapering off’ its quantitative easing but is proceeding nonetheless full throttle with them, while the BoE ended its QE programme last summer and the MPC voted 6-3 in February against restarting it.

The markets took this as a glass one-third full rather than two-thirds empty when the minutes detailing the vote were released later in the month. With the credit rating downgrade of the UK and bad economic news in the meantime, markets now look for some further easing from the British central bank.

By contrast, the Federal Open Market Committee (FMOC) minutes for January, when they were released last month, indicated growing concern among the hawks about continuing asset purchases. Though Fed Chairman Ben Bernanke insisted in congressional testimony that the Fed would maintain its accommodative stance, especially in light of automatic spending cuts that kicked in this month, currency markets now seem focused on the end of QE3 sooner rather than later.

If the Fed message is more nuanced, it is because there are more voices. Even though there are only 12 voting members on the FOMC, all 19 top officials – the seven members of the Board of Governors and the 12 regional bank presidents – take part in the debate and sometimes seem to have two dozen opinions between them.

The nine members of the MPC are in general less talkative than the FOMC members. One exception last month was David Miles, an external member of the Committee, who called for more expansion and said the Bank may have to increase its asset purchases by as much as £175bn from the current level of £375bn.

The imminent transition to a new governor at the BoE adds to the uncertainty about monetary policy, especially as the incoming head, Bank of Canada Governor Mark Carney, has indicated he wants to take a more activist approach in supporting UK growth. For one thing, it is now less certain that other MPC members will follow the lead of outgoing governor Mervyn King, who voted in favour of increased asset purchases, as they have in the past.

For another, the British government – as part of a continuing effort to react to greater uncertainty over the economy – has dropped heavy hints that it will give the Bank greater powers over the economy than has been the case under King.

This could involve formally modifying the 2% inflation target set by the government, which the Bank in recent years has consistently failed to meet, or even – in an extreme case – making a further-reaching change to the Bank’s overall mandate. However the Treasury is unlikely to give the new governor a free hand, particularly in relation to the idea he himself has floated (and then watered down) of setting monetary targets in terms of money GDP.

Whether due to a policy gap or a communications gap, the impression is that the Fed seems to be a bit ahead of the curve on QE and the Bank a bit behind. y

Whether due to a policy gap or a communications gap, the impression is that the Fed seems to be a bit ahead of the curve on QE and the Bank of England, a bit behind.

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Global analysis

4 www.omfif.org

Some leading central banks – including Russia, Japan, the US, the UK and Israel – are in the throes of leadership change. It has been rumoured that the People’s Bank

of China may get a new governor, although it now seems more likely that the much-praised incumbent Zhou Xiaochuan will stay on as a sign of continuity while the Beijing government changes. But isn’t the leadership of a central bank generally a collegial affair? Does it really matter who is governor, chairman or president?

The answer is that the choice of head need not matter, but in practice it normally does: rather a lot. Proof is not difficult to find. In mid-February, Masaaki Shirakawa, governor of the Bank of Japan, announced he would step down three weeks before his term ends, to allow a new chief to pursue a policy more suited to prime minister Shinzo Abe’s desire for more aggressive BoJ easing.

It’s clear that one of Shirakawa’s predecessors, Governor Masaru Hayami (1998-2003), by his refusal to engage in anything as ‘un-Japanese’ as

unconventional monetary policy, bears at least some of the responsibility for extending Japan’s lost years into a (first) lost decade.

By contrast, the new governor, Haruhiko Kuroda, has been picked precisely because he is expected to pursue policy – in this case easing – much more forcefully.

Is Japan unique? That is unlikely. Looking at a few other key central banks, we find similar developments. Take the Federal Reserve: Alan Greenspan clearly dominated the Federal Reserve during his long chairmanship. This meant that his views – notably that the central bank should not lean against the wind of incipient or actual asset price bubbles, but restrict itself to cleaning up after they burst – also dominated US monetary policy for close on 20 years. Greenspan rarely felt that asset prices were too high. His celebrated ‘irrational exuberance’ speech in December 2006 was an unusual exception, but his attitude soon changed to exuberant

irrationality. Greenspan was always ready to stop asset prices from falling, giving rise to the ‘Greenspan put’. Greenspan also gave the impression that he was happiest when his views were opaque.

By contrast, his successor Ben Bernanke has moved to inject considerably more transparency in the Fed. But Bernanke’s tenure also shows that there are limits to what a central bank head can do. He was clearly keen to move the Fed towards pure inflation-targeting and away from its dual mandate geared to combating both inflation and unemployment. However, although the Fed has moved towards a more explicit definition of stable prices, it retains the dual mandate.

Chairman Bernanke’s term runs out early next year. While it is too early to say anything definitive, one of his putative successors is his current vice-Chair, Janet Yellen. Should she indeed succeed him, it is likely that the Fed will move further away from inflation-targeting and re-emphasise its dual mandate.

Does that matter? Well, the Fed has certainly historically shown itself the most inflation-friendly of major central banks, with inflation averaging 2.5% over the past 20 years, compared with 2.1% in the euro area and

2.2% in the UK. So investors could be excused for thinking that a Yellen chairmanship would coincide with further above-average inflation – and would probably be good for equity prices too.

Governor Masaru Hayami, by his refusal to engage in anything as ‘un-Japanese’ as unconventional monetary policy, bears at least some of the responsibility for extending Japan’s lost years into a (first) lost decade.

Personalities matter at central banking helm Gabriel Stein, Chief Economic Adviser

the gubernatorial difference

Haruhiko Kuroda

Alan Greenspan

Janet Yellen

5March 2013

news

5March 2013

Personalities mattered in the past as well. The US and the world both suffered from the lack of a firm guiding hand at the Federal Reserve after the untimely death of the aptly named Benjamin Strong.

As far as the Bank of England is concerned, its recent history, too, supports the importance of the governor’s personality. Sir Mervyn King is generally felt to have had little interest in financial stability prior to the Great Recession, and to have been keener on the Bank of England becoming (or remaining) a first-class research institute. Arguably, this – coupled with Sir Mervyn’s abhorrence of doing anything that would smack of introducing moral hazard – was one reason behind the Bank’s initial tardy reaction to the financial crisis.

In fact, it is possibly in the UK that the change in leadership may have the biggest immediate impact. Sir Mervyn’s successor, Bank of Canada Governor Mark Carney, has indicated that he potentially would like to shift the Bank’s target from inflation to nominal GDP. (I believe this would be a big mistake and will explain why in the April Bulletin.) It is highly unlikely that any of Carney’s rivals for his new position would have embarked on this change.

Even the short history of the ECB bears witness to the importance of the personality of the man at the top. Wim Duisenberg was generally perceived to be a less than effective central bank head, who struggled to make the ECB’s position clear. By contrast, Jean-Claude Trichet was a brilliant communicator. But it took Mario Draghi’s initially overlooked statement that the ECB would do ‘whatever it takes’ – words that never would have crossed Trichet’s lips – to quieten market turmoil and at least temporarily remove thoughts of a Greek exit from the agenda. (Whether this will last is another matter.)

Meanwhile, in Russia, the imminent replacement of Sergei Ignatiev, whose mandate expires at the end of June, has led to an internal debate about what and how much the central bank can do to boost growth. Ultimately, of course, very little. But that doesn’t stop politicians from wanting it to act. In the Russian case, it seems that the search is on for a new head, who here too will pursue a policy of low interest and less concentration on inflation. But we mustn’t leap to false conclusions. In Japan – even though the case is not entirely convincing – higher inflation may indeed be helpful. Yet it is doubtful whether that is really what is needed in Russia – where consumer prices rose by 6.6% in 2012.

Even from this small sample, it seems clear that the governor’s personality will make a difference. Nor is this a recent development. It is true that the independence – formal or otherwise – of central banks is a fairly new phenomenon. But, as Liaquat Ahamet’s book Lords of Finance shows, personalities mattered in the past as well. The US and the world both suffered from the lack of a firm guiding hand at the Federal Reserve after the untimely death in 1928 (at age 55) of the aptly named Benjamin Strong, President of the New York Fed from 1914 to 1928.

But if the Fed lacked strength, the Bank of England probably had too much of it in the shape of Montagu Norman, Governor from 1920 to 1944. Some say he was originally appointed because he had suffered a nervous breakdown and it was felt that he needed a quiet position in which he could recover. Norman successfully browbeat successive Chancellors of the Exchequer and thus must share the responsibility for the UK’s disastrous return to the gold standard in 1925.

More examples can no doubt be found. Some of these differences are differences in style; others are differences in approach to monetary policy, some are merely personal attitudes. But whatever their cause, it is quite clear that the personality of the individual at the central banking helm is enormously important. This is a subject to which, in the past, perhaps too little attention has been given. The gubernatorial difference is a significant issue. With the role of central banks and central bankers becoming more important, and their independence under great scrutiny and even threat, this is likely to become ever more so in the future. y

Benjamin Strong

Jean-Claude Trichet

Mark Carney

Montagu Norman

Banknotes – the Fed

6 www.omfif.org

The debate among Federal Reserve policy-makers regarding their programme of asset purchases, or quantitative easing, is picking up steam as the view gains ground on financial markets that easier money will continue for a while yet.

Two new developments have surfaced as variations on the Fed’s theme. One is a ‘tapering’ option of gradually reducing the amount of bond purchases the Fed is making as part of its monetary accommodation, rather than proceeding at full speed and then stopping altogether. The other is for the Fed to slow down the exit from quantitative easing by holding the securities to maturity rather than selling them as previously planned.

Fed hawks and doves debated these possibilities against a backdrop of uncertainty about how long or how deeply Congress would allow automatic spending cuts to take place on 1 March without taking countervailing action.

Fed will remain accommodating amid fiscal uncertainty

When Fed Chairman Ben Bernanke (voter) appeared before Congress at the end of February for his semiannual testimony on monetary policy, it was evident there would be no last-minute legislation to stop the so-called ‘sequestration’. Bernanke did not hesitate to affirm that the Fed would maintain its accommodative policies.

‘In the current economic environment, the benefits of asset purchases, and of policy accommodation more generally, are clear,’ Bernanke said in testimony before Senate and House panels. ‘Monetary policy is providing important support to the recovery while keeping inflation close to the FOMC’s 2% objective.’Bernanke also made it as clear as tactfully possible that he thought sequestration was a bad idea. He

encouraged lawmakers to forgo any further cuts in near-term spending and instead adopt measures that would substantially reduce the deficit in the longer term.

‘Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant,’ Bernanke said, referring to the immediate cuts required by the sequestration. ‘Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run.’

Bernanke’s affirmation of QE3 reassured markets that had been somewhat spooked when minutes of the January meeting released last month revealed that some FOMC members had reservations about continuing the programme for the full year.

‘A number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred,’ the minutes said.

The minutes also raised the possibility of prolonging the Fed’s exit from accommodative policy. ‘[A] number of participants discussed the possibility of providing monetary accommodation by holding securities for a longer period than envisioned in the Committee’s exit principles, either as a supplement to, or a replacement for, asset purchases,’ the minutes said.

Timing the tapering

St. Louis Fed President James Bullard (voter) told reporters following his speech in Arkansas in mid-February that he was one of the fans of the tapering option, given signs of progress in the labour market.‘As you see improvement, you should acknowledge that improvement and say we’ll go down to $75bn a month, or something like that, and as you continue to see improvement you make a little bit more of a tapering,’ he said, according to news agency reports.

Dennis Lockhart (non-voter), head of the Atlanta Fed, said that he supports the current level of asset purchases for the time being. ‘Given the outlook and associated risks, I am comfortable with sticking with the current approach at least into the second half of the year,’ he said in Knoxville, Tennessee.

However, he recalled that the FOMC, in contrast to earlier asset-purchase programmes, had set neither an amount nor duration for the current round, indicating he might also support tapering off if the labor market improves.

New QE developments as fiscal uncertainty bitesDarrell Delamaide, Board of Contributing Editors

Qe debate picks up steam

Ben Bernanke

James Bullard

news

7March 2013

While some Fed hawks remain sceptical, they also tend to favour the tapering option rather than an abrupt halt to the asset purchases. Dallas Fed chief Richard Fisher (non-voter) said he had opposed new rounds of quantitative easing because in the real world of business, cheap money alone was not enough to encourage employers to expand.

‘I was, indeed, against the escalating rounds of QE, questioning their efficacy,’ Fisher told an audience at Columbia University in New York. ‘But now that we have them in place, and the fixed-income and stock markets are hooked on the monetary Ritalin that we have dispensed in ever-larger doses, it would, in my opinion, do great harm to force a sudden withdrawal.’

Paper profit

A number of FOMC members played down concerns that have arisen after the Fed’s inflated balance sheet has generated record profits and record remittances to the US Treasury. Some economists worry that these remittances will decline sharply or cease altogether once interest rates rise again and the Fed begins shrinking its balance sheet.

‘This discussion does not do justice to the policy trade-offs,’ Boston Fed President Eric Rosengren (voter) said in a speech in New York. ‘The [asset-purchase] programme improves the broader fiscal outlook by lowering interest rates and providing more economic growth.’

San Francisco Fed chief John Williams (non-voter) chimed in with similar sentiments. He said that the prospect of losing money at some later date should not keep the Fed from an aggressively accommodative policy now. For one thing, he noted, the Fed can carry any losses indefinitely until profit returns, so that the risk ‘in no way hinders or interferes with us conducting monetary policy’.

In his congressional testimony, Bernanke also played down the risk of reduced remittances. ‘Even in such scenarios, it is highly likely that average annual remittances…will remain higher than the pre-crisis norm, perhaps substantially so’, he said. ‘Moreover, to the extent that monetary policy promotes growth and job creation, the resulting reduction in the federal deficit would dwarf any variation in the Federal Reserve’s remittances to the Treasury.’

Defending the dual mandate

During Bernanke’s testimony last month, one of the lawmakers, Republican Senator Bob Corker of Tennessee, took the Fed chairman to task for what he termed ‘degrading’ society by encouraging Americans to live beyond their means. ‘Do you all ever talk,’ Corker asked the witness, ‘about the longer-term degrading effect of these policies as we try to live for today?’

Bernanke did not answer the question directly but instead named one long-term worry he does have that seems to get little discussion in Congress: ‘I think one concern we have is the effect of long-term unemployment and the people who haven’t had jobs for years. That means they’re never going to acquire skills for years and be a productive part of our workforce.’

The Fed, Bernanke reminded the senator, has a dual mandate of fostering maximum employment and holding down inflation. At a Washington event earlier in the month sponsored by the labour confederation AFL-CIO, Fed Vice Chairman Janet Yellen (voter) noted that in fact ‘the Federal Reserve is the only agency assigned the job of pursuing maximum employment’ thanks to the 1977 law creating the dual mandate.

‘The gulf between maximum employment and the very difficult conditions workers face today helps explain the urgency behind the Federal Reserve’s efforts to strengthen the recovery,’ Yellen said. ‘My colleagues and I are acutely aware of how much workers have lost in the past five years. In response, we have taken, and are continuing to take, forceful action to increase the pace of economic growth and job creation.’ y

Janet Yellen noted that ‘the Federal Reserve is the only agency assigned the job of pursuing maximum employment’ thanks to the 1977 law creating the dual mandate.

news

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Abe’s governor (... continued from page 1)

As a result of the switch from incumbent Masayuki Shirakawa to Kuroda, the BoJ management now looks likely to shift towards greater dynamism. Kuroda has shown strong leadership at the ADB since his term began in 2005, when the institution’s raison d’etre was put in doubt by the Asian economies’ development success.

Once in his post, Kuroda pushed the idea of integrating Asian economies especially in bond markets. And he succeeded in obtaining member countries’ consent, led by the US, to triple the ADB’s capital base. Kuroda once told me that he respects the determination of his long-time friend Mario Draghi, European Central Bank president. As leader of the BoJ, Kurodo can be expected to display similar innovativeness and determination.

Several past episodes in which Kuroda played important roles illustrate the scope of the expected transition.

When the Asian financial crisis erupted in 1997, the Japanese government proposed an innovative solution: an Asian Monetary Fund to provide much-needed liquidity. The project did not materialise, owing to strong US objections, especially from then Treasury Secretary Laurence Summers.

But the discussions gave rise to a slimmed-down project of bilateral swap agreements under the Chiang Mai initiatives which Asian finance ministries and central banks are trying to extend further today.

In the aftermath of the Lehman Bros collapse in 2008, Korea was hit by

an acute dollar shortage like in 1997. A Korean delegation flew to Japan asking urgently for a dollar swap agreement between the Bank of Korea and Bank of Japan, reflecting Korea’s reluctance to risk a repeat of the negative 1997 experience of a rescue from the International Monetary Fund.

The Korean initiative was frustrated by the BoJ’s outright rejection under governor Shirakawa. This prompted the delegation to fly to Washington to seek a deal with the Federal Reserve, which was immediately agreed by chairman Ben Bernanke and later extended to include the People’s Bank of China and the BoJ. Undoubtedly, the BoJ will now move on from Shirakawa’s relatively narrow-minded attitude and display greater leadership at an Asian and wider international level. y

Rome’s mess extends beyond Italy (... continued from page 1)

Politics is the science of sharing burdens fairly, or at least convincing people that that’s what’s happening. In the face of economic crisis, politics is failing. This is similar to the 1930s when the world experimented with new forms of authority-fascism and Bolshevism and Social Democracy. None quite did the job. War came, and rescued the Western economies. This time fascism and Bolshevism are no longer feasible. We are all democracies. Stunningly, this makes us all incapable making the right choices.

We see the brute force of politics in the US, which has now crashed into sequestration. That seems to be the only possible way to tackle its debt/deficit given the gridlock in the politics. There’s no way for a reasoned solution as of now, given the vast distance between the rival refuseniks of tax increases and spending cuts. The

Republicans want to spare the rich pain, the Democrats wish to protect public spending without too much questioning.

In the UK, the latest by-election result, with Tories coming behind the anti-euro UKIP, may lead to nervousness about the persistence of UK chancellor of the exchequer George Osborne’s budget cuts policy. The British system cannot draw clear lines between the hardliners and the Keynesians, since the coalition is a muddle of the two camps.

In India, as the latest Budget shows, government and opposition are beset by fear of reforms ahead of an election. In China the neophytes taking over the government reins have been surprised by the popular upsurge against pollution as well as latent industrial unrest. China enjoys growth but its costs have not been fairly shared.

What’s going on? Rebuilding productive capacity even with the newer developments in industrial technology, such as three-dimensional printing and so on, requires a lot of savings as well as restoration of competitive wages. Years of Keynesian solutions and spending boosts to solve recessions have inured western polities to the need for hard choices.

The central issue behind worldwide political gridlocks is that politicians have not been able to agree on a fair distribution of the costs of structural adjustment.

The Grillini do not trust politicians as a class, and refuse to accept that the debt must be paid. They want the politicians who got them into this mess to pay, but leave open how to do it. Well beyond the land of Beppo Grillo, the Grillini are with us, everywhere. y

‘The budget deficit will probably stand at 3.7% of GDP in 2013 even though we will try to make it lower.’ French President François Hollande, 12 March 2013.

Quote of the month

newsBank liquidity management

9March 2013

Why conservative principles on liquidity make senseMoorad Choudhry, Advisory Board

Back to banking basics

Maturity transformation is the very essence of banking. This naturally involves a degree of risk. So how does one mitigate it?

The basis of banking is to ‘borrow short to lend long’. This was the practice I saw decried in a seemingly -serious prominently-displayed contribution to the letters page of The Times of London at the height of the financial crash – one of the most amusing letters I have ever seen in that newspaper.

By definition, banks never raise liabilities of similar contractual tenor to assets. That’s the nature of supply and demand for cash. The very act of banking demands that we assume something that can never be guaranteed: the ability continuously to roll over required funding. Banks do not fund on a matched basis, because such practice is a practical impossibility. (It is debatable whether they would do so even if they could). So it’s necessary to address the liquidity gap risk by other means. When allowing for ‘behaviouralised’ tenor of assets and liabilities, a substantial funding gap remains.

Basel III seeks to address this issue with its LCR and NSFR liquidity regime, discussed in Part 1 of this series (OMFIF Monthly Bulletin, January 2013, p.16). Yet bankers commonly say that ‘liquidity risk management’ is more than just these two ratios, and conversely that these two ratios do not capture all the nuances of liquidity risk.

The most effective response to funding risk is a back-to-basics regime. This means changes to prevailing bank business models. The current ones were developed to address the globalised era and the need to reduce costs to remain competitive. Paradoxically, the threat to western economies comes from Asia-Pacific counties, yet the banks in that region exhibit a more conservative liquidity regime than those in the west.

Rather than focus solely on the two metrics, a more natural approach to liquidity risk would be to accept that the business model has changed, principally due to the need to incorporate the three key mitigants of funding risk: a material share of contractual term funding, a genuinely liquid ‘liquidity portfolio’, and a robust internal funding regime. (Markets call that ‘funds transfer pricing’ but it is more accurately termed an internal borrowing or lending rate).

The first requirement is self-evident. Since continuous liquidity cannot be assured under all circumstances, it is necessary to have a sufficient share of balance sheet funding comprised of long-dated liabilities. The second requirement arises from the same reality. Liquidity needs to be maintained in cash or very liquid assets.

The third requirement is as important as the first two but frequently misrepresented. To ensure that assets generating liquidity stress on the balance sheet are adequately priced, it is necessary to incorporate the correct term liquidity premium at the origination level.

Unfortunately this is often confused with the need to pass on the bank’s marginal funding cost in the internal pricing methodology, rather than the price of pure term liquidity, and so has the potential to become very contentious. In fact, a robust approach to internal funds pricing is the key control mechanism reducing the chances of another liquidity crash occurring in the near future.

All this may be self-evident. It should be. These principles would all have ruled without exception in banks during the 1960s … or indeed the 1860s. y

The threat to western economies comes from Asia-Pacific counties, yet the banks in that region exhibit a more conservative liquidity regime than those in the west.

This is part 3 in a series of articles on bank liquidity. Professor Moorad Choudhry is a member of the OMFIF Advisory Board. The views and opinions expressed herein are solely those of the author.

Future of eMu

10 www.omfif.org

I am an enthusiastic supporter of banking union in Europe. As we work at breakneck speed to construct what is undoubtedly a most ambitious project, it is worthwhile focusing

on five hopes for what we can achieve from the project.

My first hope is that banking union will go some way to removing politics from the enforcement of bank supervision. Politics and banking don’t fit well together but they seem to have a magnetic attraction to each another. In some circumstances, bankers’ political prominence on the national stage can result in implicit pressures to hesitate or second-guess regulatory action.

International experience generally shows that the best form of regulation for delivering the common good is technocratic and wholly insensitive to national, regional or local politics. That can best be delivered by a regulator that lacks an understanding of, and interest in, such politics. Outsiders will often fit this description very well.

An outside regulator needs to rely on the instinct of the local supervisors for the assembly of relevant information. It is chiefly in making the final decision on regulatory interventions that the need for political distance becomes evident. Indeed, it is not so much in supervision, as in resolution that these issues become decisive. This points to the need to complement the single European supervisory mechanism with a single resolution authority.

My second hope is that banking union brings emotional detachment to the process of supervision. In contrast to the political issues, which will often relate to isolated cases, what I have in mind here is the problem of the waves of euphoria and over-optimism which have a tendency to sweep through financial systems, often driven by – and driving – property bubbles. If the entire banking system, and the property market gurus, and the beneficiaries of the spin-off economic activity and stock market appreciation all become cheerleaders for the continuation of credit-fuelled bubbles, the regulator may still stand in opposition.

All too often, however, the regulator is insufficiently detached. A sneaking suspicion that the market may be wrong is weakened or drowned out by the plausible chorus of boosters to which the local regulator is exposed. We must hope that the outsider will embody the scepticism that is natural for all regulators.

Third, I hope that banking union manages to make use of the diversity of supervisory experience and aptitude across Europe to provide multiple cross-checks on bank soundness, while not imposing a straitjacket on bank behaviour. This feeling derives from the observation that supervisory practice differs quite significantly in Europe. No doubt every supervisory agency thinks it does the job better than every other one, but this is impossible. At the Central Bank of Ireland, we have recently unveiled a computerised tool (called PRISM) for guiding and recording supervisory engagement. It provides a great advance especially for dealing in a systematic way with the supervision of financial firms to which an impact factor below the very highest has been applied.

We think PRISM embodies much of the accumulated experience (good and bad) Ireland has gained over the years. I am sure there are aspects that could benefit from a different approach. To be sure, supervisors have been talking to each other in Europe and internationally for years. Yet there is no agreed supervisory manual. The banking union will inevitably result in further moves in that direction. The single supervisory mechanism will itself embody a single methodology.

A single manual does not mean that banks shall be treated in the same way regardless of the macroeconomic context. It means that similar risks should be approached with the same tools, and stringency, everywhere in the union.

Five hopes for European banking unionPatrick Honohan, Governor, Central Bank of Ireland

Solidity through detachment

Supervisory practice differs quite significantly in Europe. No doubt every supervisory agency thinks it does the job better than every other one, but this is impossible.

newsnews

11March 2013

This article is an abbreviated version of a speech by Mr Honohan at a symposium on ‘Central banking: where are we headed?’ in honour of Stefan Gerlach, at the Institute for Monetary and Financial Stability Symposium, J.W. Goethe University, Frankfurt, 7 February 2013.

Waves of distrust in European banking have damaged the recovery and increased the degree to which European banks have had to have recourse to central bank funding and government capital.

By mixing and cross-referencing the practical experience of many different systems, the combined forces of Europe’s supervisory agencies has the potential to make early detection of novel risks.

Fourth, I hope banking union is effective in breaking the link between sovereign and banks. This is not only to protect the sovereign but also to allow banks to operate effectively and have access to European funding markets on a basis that is not subject to a sovereign risk-add on, but depends only on the bank’s own creditworthiness and standing.

We can all agree upon that the Irish syndrome cannot be allowed to recur. Features of the Irish case were (i) banks which accumulated vast exposures to the Irish property bubble financed with cross-border wholesale funding; (ii) the government that stepped in to guarantee the funding (in ignorance of the hidden exposure to crippling loan-losses); (iii) central bank financing of the outflows that occurred when wholesale markets lost confidence in the guarantor; (iv) the sovereign being forced into official financing to spread out the cash repayment of the indebtedness accumulated as a result of meeting loan losses and the bank recapitalisation.

I hope that the banking union will be (i) more effective in preventing unsound banking practices on this scale, with interventions that pre-empt a slide into insolvency. Additionally, I hope there will be (ii) a resolution law and institutional arrangements that make a bail-out of bank creditors a thing of the past (because of sufficient bail-in-able debt even to cover cases where supervision is insufficient to prevent insolvency).

Therefore (iii) there’ll be no risk to the sovereign from banking weakness; and (iv) where needed, a public financial backstop will be available at European level to top up depleted capital for viable banks that have lost some of their capital.

Fifth, I hope that the banking union helps provide reassurance to bond and equity investors, both public and private, to underpin and finance needed liquidity and the much higher Basel capital requirements that are needed to redress incentives for excessive risk-taking. There is no merit in looking to public financing as the long-term solution for European banks. Waves of distrust in European banking have damaged the recovery and increased the degree to which European banks have had to have recourse to central bank funding and government capital. Here I am not just speaking of the ‘programme countries’. Some of these flows related to market perceptions of systemic risks across the euro area. Happily these perceptions have been silenced by policy action.

Collective action to supervise, and where necessary, intervene and resolve banks will restore more completely than has yet been possible, and on a lasting basis, market confidence in the operation and regulation of the banking system throughout Europe. y

‘As Victor Hugo once remarked,”You can resist an invading army; you cannot resist an idea whose time is come.” I believe that banking union is just such an idea.’

Vítor Constâncio, Vice President, European Central Bank, London, 11 March 2013.

Constâncio on banking union

World economy

12 www.omfif.org

Signs are coming to the surface that Japan’s cocktail of currency

devaluation, fiscal and monetary easing is taking effect. The Economy Watchers survey has a strong correlation with the GDP cycle and it is rising sharply. Chinese activity is also picking up with strong M1 growth and the HSBC PMI at a two year high.

Even the euro area looks set to surprise a pessimistic consensus, judged by the pace of the money supply growth. On this basis, the fourth quarter of 2012 was the low point in the cycle, and from now on world economic developments will be a great deal more positive.

With US consumer spending firm, Chinese activity picking up and laggard economies Japan and the euro area pursuing reflationary policies, the prospects for synchronised global recovery are very good.

Positive economic surprises should see further upside for stock prices despite frothy sentiment readings. This should bring benefits for Japanese equities and emerging markets in spite of recent underperformance.

A fall in macroeconomic uncertainly favours bottom-up stock-pickers.

Emerging economies gain traction from market riseTrevor Greetham, Advisory Board

Japan leads the way

Chart 1: Signs of change in stock prices and the yen Chart 2: Japanese Economy Watchers’ Survey and GDP

Source: Datastream, January 2013 Source: Datastream, January 2013

Yen-dollar exchange rate (R.H.scale) Nikkel 225 stock average price index Japan Economy Watchers’ Survey (R.H.scale) Japan real GDP YoY%

The Fidelity global growth scorecard turned positive in December for the first time since June 2012. But inflation pressures remain muted.

The Investment Clock model that guides asset allocation decisions is in the equity-friendly Recovery phase, following the theoretical ‘Clockwise’ path for the first time since the financial crisis. G7 monetary policy is loose and a fundamental change in central bank attitudes means policy is likely to stay that way even if inflation pressures start to build.

The major developed economies have been in a debt trap with 1930s-style debt deflation the main risk. The US is showing signs of escaping first. Loose monetary policy has weakened the dollar.

House prices are rising with the Fed directly buying mortgage-backed securities. Banks are lending once more. Fiscal tightening has been delayed until a recovery is well under way.

Japan was first into the debt trap. Land prices have fallen every year since 1991. For many years Japanese policy makers believed there was nothing

they could do. Now, seeing America making progress, a new government has decided to change things. Japan is aggressively easing both fiscal and monetary policy.

Yen weakness is a welcome and beneficial side effect. With Upper House elections in July, policy news flow is likely to remain positive. If the economy can recover, then the rise in stock prices ought to last at least a year.

With US consumer spending firm and laggard economies set up to recover, we are likely to see a period of synchronised global growth.

Corporate earnings growth should be much better than expected. Commodity prices should rise. Our main equity overweight is in emerging markets.

We see recent underperformance as a temporary phenomenon, partly reflecting strong US performance and partly reflecting the impact of yen weakness on competitor economies like South Korea.

Emerging market outperformance should resume if yen weakness pauses or commodity prices start to rise in earnest. y

newseurope & the world

13March 2013

Europe’s powerhouse linkages with rest of world Michael Holstein, DZ Bank

German economy looks east

Germany’s foreign trade is undergoing deep and, it seems, unstoppable change. The importance of Germany’s traditional trading partners from the industrialised nations

is dwindling. Emerging market economies, above all those in Asia and eastern Europe, are gaining considerable momentum in German trade. And that seems likely to continue.

In 2012 , the German economy’s most important trading partner was once again France, followed by the Netherlands. Three other members of economic and monetary union (EMU) were among the top ten trading partners, namely Italy, Austria and Belgium. But the important positions of Germany’s EMU neighbours should not mislead us about the size of the structural shifts in Germany’s foreign trade in recent years.

When EMU was launched in 1999, the other member states in the euro area absorbed more than 46% of Germany’s total exports. By 2012, the figure dipped to below 38%. While German exports to France and other EMU states have increased since the euro started, they have lagged well behind overall growth in exports. The significance of other EMU members for German exports has steadily fallen. This is the opposite of what could have been expected at the beginning, when the single currency was designed to simplify the exchange of goods within Europe and this increase trade flows among neighbours. The advent of the euro may initially have braked German’s eastward export surge, but it certainly has not stopped it.

In 2012, China took third place in the league table of Germany’s most important trading partners. Its share has more than trebled since 1999. Asia now accounts for more than 17% of overall German foreign trade, compared with 12% in 1999. Exports to Asia have climbed more than 10% a year since 1999, with exports to China up 19% a year.

Russia has likewise gained vastly in importance and is now among Germany’s top ten trading partners. Moreover, the three major central and east European countries, namely Poland, the Czech Republic and Hungary, have all gained a lot of ground, with their combined share of total German exports now just short of 9%, more than that of France.

Compared with Germany, the flow of foreign trade for the other major EMU member states is still largely focused on the euro area. Indeed, for France, Italy, Spain, and the Netherlands, the euro area still accounts in each case for well over 40% of foreign trade. However, there is no overlooking the fact that the euro area’s importance is also dwindling for these countries. As in Germany, for these countries too, the foreign trade advance of the dynamic economies of Asia and eastern Europe is inescapable.

On balance, the lesson of the foreign trade data is that the new eastern focus of euro members towards the fast-growing economies of Asia and eastern Europe has occurred not because of the introduction of the euro, but despite it. The sheer existence of the euro has been insufficient to redirect the flow of trade towards countries which made up a very significant part of the world economy in the past, but are now becoming, in relative terms, much smaller components. This reflects the growing importance of emerging markets in the global economy and the increasing pace of globalisation in manufacturing and trade.

The euro, in particular regarding the German economy, has acted as a catalyst, less for inner-EMU trade and far more for trade with the rest of the world. With the introduction of the euro, the German economy’s competitive edge has became sharper, as the continuing pressure to revalue its currency (something often experienced during the days of the D-Mark) is now a thing of the past. One of the political reasons for the introduction of the euro was to bind Germany more fully into Europe. It is a supreme paradox that one of the abiding legacies of the euro has been to make Europe’s most powerful economy less dependent on its neighbours, and more economically connected with the rest of the world. y

The lesson of the foreign trade data is that the new eastern focus of euro members towards the fast-growing economies of Asia and eastern Europe has occurred not because of the introduction of the euro, but despite it.

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newsnewsWorld economy

15March 2013

Rewards beckon for Europe and USBruce Stokes, Pew Research Center

Support for trade link

After nearly two decades of debating the idea and several false starts, the US and the European Union will soon begin negotiating a trade and investment agreement. Talks

are likely to be formally launched on the verges of the G8 summit in June in the UK, with official deliberations getting underway either in July or September.

The hope is to complete negotiations before the current European Commission leaves office in autumn 2014. The timetable is ambitious but a good deal of pre-negotiation has already taken place to clear out several obstacles, notably involving agricultural issues. The talks are likely to be disputatious, with serious opposition from vested interests on both sides, but they also promise very large economic rewards.

Public opinion on both sides of the Atlantic would appear to be receptive to the idea. The virulent European anti-Americanism of the last decade is ancient history. More than two-thirds (69%) of the French had a favourable view of the US in 2012, compared with 42% in 2008, the last year of the administration of George W. Bush, according to Pew Research Center surveys. Similarly, 52% of Germans held a positive opinion of America, compared with 31% four years earlier. And 58% of the Spanish were favorably disposed toward the US, much greater than the 33% who held such views in 2008.

Moreover, contrary to the widespread assumption that protectionist sentiments are rising in the wake of the Great Recession, 58% of Americans say they support increased trade with the EU.

As Brussels and Washington pursue this course, there is robust support for such an effort.

Three-quarters of the Italians, nearly two-thirds of the British (65%) and more than half of the French (58%) and Germans (57%) believe in deepening trade and investment ties between the European Union and the United States; 63% of Americans agree, according to a 2007 German Marshall Fund survey.

There is also strong support for one of the thorniest challenges that lie ahead: harmonisation or mutual recognition of national regulations on goods and services, everything from food standards to insurance. Overwhelmingly Italians (87%), British (84%), French (82%), Americans (76%) and Germans (71%) support such efforts, according to a 2007 German Marshall Fund survey.

The removal of all remaining tariffs on goods traded between Europe and the United States, traditionally the core of any trade and investment agreement, has strong, if slightly less enthusiastic support, on both sides of the Atlantic. Fully 70% of the British and Italians, 65% of the Poles and 54% of the Germans back such an effort, according to the GMF survey. Roughly half of the French (50%) and Americans (48%) agree.

Once actual trade and investment negotiations finally get under way, the bargaining is likely to be difficult. If history is any guide, inevitable frictions will erode public support as adversely affected interests complain, while those that stand to benefit are less vocal. So the ultimate public verdict on an EU-US trade and investment agreement has yet to be rendered.

But on the eve of negotiations, both Americans and Europeans seem disposed to head towards a goal that, if reached, should raise spirits on both sides of the Atlantic. y

The virulent European anti-Americanism of the last decade is ancient history; 69% of the French had a favourable view of the US in 2012, compared with 42% in 2008.

For more details on Pew Research on Global Attitudes, see http://www.pewglobal.org/2012/06/13/global-opinion-of-obama-slips-international-policies-faulted/

newsnewseurope & the world

17March 2013

EU can proceed without UK membershipPhilippe de Schoutheete, Former Belgian Permanent Representative to the EU

Cameron’s european gamble

The European policy announced in the January speech of British prime minister David Cameron is a two-fold gamble. His first bet is that he will persuade European partners

to change some agreed policies or decisions that are no longer convenient for British public opinion. He then further bets that these changes, presumably substantial, will enable him to win a referendum in 2017 on the UK’s future status in the European Union. Both stages seem quite hazardous. The first bet opens a Pandora’s box most member states do not wish to open. The second implies all the risks of a referendum to be held in five years, in unforeseen circumstances, on the basis of a new treaty of unknown content. Yet the result of this gamble is of interest to us all.

Forty years ago, Belgium, together with the Netherlands and Luxembourg, made its best diplomatic efforts actively to favour British accession to the European Community. They were operating along the lines of a century-old tradition which implies that this part of Europe should always try to keep a balance in the influence, and at times conflicting ambitions, of its big neighbours: Germany, France and Britain.

With hindsight, we have to acknowledge that our optimism was not justified. We underestimated the novel character, the historical nature and the specific dynamics of the 1950s initiatives leading to European integration. The aim was no longer, as before, to balance the influence of sovereign neighbours, but to succeed in the exercise of shared sovereignty, which is a quite different challenge.

The fact remains that Britain neither found nor sought the leading role that could have been expected. Defensive positions on all the rest: no novelties, no new policies, above all no new rules, no new treaties, the status quo. The realm of opting out! Cameron’s speech simply accentuates a now-traditional orientation. His central point is that the EU, largely because of the euro crisis, is heading for a level of political integration that is far outside Britain’s comfort zone. He wants more flexibility, power to flow back to member states, legislation reconsidered, rules diminished, obligations decreased.

A striking point is the specific and sharp criticism of the goal of ‘an ever closer union’. These words come from the preamble of the Rome treaty, a treaty to which successive British governments, at the time, urgently wanted to gain access. The formula, despite its defects, has been, over 50 years, the only generally accepted form of words to describe the ultimate objective of the European process. To put it in question is not a minor issue.

Cameron indicates that, if he were to lose his gamble, Britain could make her own way in the world, outside the EU. I would add that the EU could make its own way in the world without Britain as a member.

Should we then hope that he wins his hazardous gamble? The greater EU integration now necessary implies treaty modifications, which, in the present legal situation, requires unanimous decisions by member states. It becomes problematic to go down that road with a partner who now says he wants to lower the level of integration. In the case of the fiscal compact, we circumvented the British veto by leaving, for a time, the institutional framework of the Union. But there is a danger signal: if we go on, we will marginalise the institutions which have been, since the very beginning, at the core of the European process.

A pessimist might say that whether Cameron wins or loses his gamble, the EU has nothing to win. An optimist might prefer to predict he will lose the next election. y

Cameron indicates that Britain could make her own way in the world, outside the EU. I would add that the EU could make its own way in the world without Britain as a member.

This is an abbreviated version of a text initially published in French in La Libre Belgique on 16 February under the title ‘Le Pari de Monsieur Cameron’.

Global analysis

18 www.omfif.org

european trade trends Structure of foreign trade: Germany Countries/regions Share in total trade

in %Share in total exports in %

Share in total imports in %

Growth rates2011/2012e

Average annual growth rates 1999-2012

1999 2012e 1999 2012e 1999 2012e total trade exports imports total trade exports imports

EU (27) 64.2 56.7 65.7 57.0 62.5 56.3 0.9 0.3 1.6 4.9 5.0 4.9

EMU (16) 45.7 37.6 46.4 37.5 45.0 37.7 -0.1 -1.5 1.7 4.4 4.4 4.3

EMU core (BE, NL, AUS) 17.8 17.1 18.1 16.3 17.5 18.1 1.1 -0.6 3.1 5.6 5.3 6.0

France 11.0 8.4 11.6 9.5 10.3 7.1 1.1 3.0 -1.8 3.8 4.6 2.7

EMU periphery (IT, ES, PT, IRL) 14.1 9.2 13.8 8.9 14.5 9.5 -5.8 -9.5 -1.1 2.3 2.6 3.1

Poland 2.3 3.8 2.4 3.8 2.1 3.7 -0.2 -3.0 3.7 10.1 9.9 10.4

Turkey 1.2 1.6 1.2 1.8 1.3 1.3 0.4 -0.2 1.6 8.2 9.9 5.9

UK 7.8 5.8 8.5 6.6 7.0 4.8 4.9 10.1 -2.7 3.5 4.0 2.7

Russia 1.4 4.0 1.0 3.5 1.9 4.7 6.9 10.4 3.8 14.8 16.8 13.3

Brazil 0.8 1.1 0.9 1.1 0.7 1.2 -0.5 4.7 -5.7 8.3 7.4 9.4

India 0.3 0.9 0.4 0.9 0.2 0.8 -5.5 -4.3 -7.2 14.6 14.2 15.4

US 9.2 6.9 10.1 7.9 8.3 5.6 13.4 19.1 4.9 3.6 4.2 2.5

China 2.2 7.2 1.4 6.1 3.1 8.5 -0.3 2.7 -2.8 16.1 19.0 14.2

Asia 12.4 17.2 9.8 16.3 15.3 18.2 1.4 6.9 5.9 8.6 10.4 7.1

Eastern Europe (PL, CZ, HU) 6.2 8.7 6.1 8.2 6.4 9.4 1.3 0.0 2.7 8.7 8.6 8.9

Total 2.7 4.1 1.1 5.9 6.1 5.7

Germany increased its trade with the rest of the EU by an annual average 4.9% during the period 1999-2012, and with the EMU states by 4.4% – compared with 16.1% in the case of China; Russia, 14.8%; Brazil, 8.3%; and India, 14.6%.

France increased its trade with the rest of the EU by an annual average 3.3% during the period 1999-2012, and with the EMU states by 3.5% – compared with 13.7% in the case of China; Russia, 13.5%; Brazil, 7.5%; and India, 11.1%.

Structure of foreign trade: France Countries/regions Share in total trade






EU (27) 66.4 58.4 67.0 58.2 65.7 58.6 1.7 1.3 2.1 3.3 2.5 4.2

EMU (17) 52.4 47.1 52.1 46.0 52.8 48.1 1.6 0.8 2.3 3.5 2.6 4.4

EMU core (BE/LUX, NL, AUS) 13.6 13.1 13.5 12.7 13.6 13.4 3.2 4.7 2.0 4.1 3.1 5.0

Germany 16.7 16.9 15.6 16.2 17.7 17.5 3.4 3.1 3.7 4.5 3.9 5.0

EMU periphery (IT, ESP, PT, IRL) 20.5 15.5 18.2 15.6 22.9 15.3 -1.1 -1.9 -0.5 2.1 2.3 1.9

Poland 0.7 1.5 1.0 1.5 0.5 1.6 2.0 0.8 3.1 10.4 7.2 14.6

Turkey 0.9 1.3 1.0 1.6 0.7 1.1 -0.4 2.9 -4.2 7.9 7.0 9.2

UK 9.5 5.5 8.2 5.2 10.8 5.8 5.0 6.2 3.5 0.1 0.1 0.0

Russia 0.7 2.2 0.5 2.1 1.0 2.3 -0.9 24.5 -14.3 13.5 16.4 11.8

Brazil 0.6 0.9 0.6 1.0 0.7 0.8 9.6 15.7 3.5 7.5 7.9 7.1

India 0.4 0.8 0.3 0.7 0.4 0.9 5.1 17.3 -2.1 11.1 10.4 11.6

US 8.3 6.3 7.6 6.0 9.0 6.5 13.8 13.8 13.8 2.2 1.7 2.6

China 2.0 6.0 1.1 3.4 2.8 8.2 4.1 12.9 1.3 13.7 13.1 14.0

Asia 9.5 14.4 7.0 12.6 12.2 15.9 7.3 14.7 2.7 7.7 8.4 7.3

Eastern Europe (PL, CZ, HU) 1.6 3.1 2.7 2.9 1.4 3.3 -0.8 -0.3 -1.1 9.8 7.3 12.5

Total 3.0 4.1 2.0 4.4 3.6 5.1

news

19March 2013

Structure of foreign trade: France Countries/regions Share in total trade






EU (27) 66.4 58.4 67.0 58.2 65.7 58.6 1.7 1.3 2.1 3.3 2.5 4.2

EMU (17) 52.4 47.1 52.1 46.0 52.8 48.1 1.6 0.8 2.3 3.5 2.6 4.4

EMU core (BE/LUX, NL, AUS) 13.6 13.1 13.5 12.7 13.6 13.4 3.2 4.7 2.0 4.1 3.1 5.0

Germany 16.7 16.9 15.6 16.2 17.7 17.5 3.4 3.1 3.7 4.5 3.9 5.0

EMU periphery (IT, ESP, PT, IRL) 20.5 15.5 18.2 15.6 22.9 15.3 -1.1 -1.9 -0.5 2.1 2.3 1.9

Poland 0.7 1.5 1.0 1.5 0.5 1.6 2.0 0.8 3.1 10.4 7.2 14.6

Turkey 0.9 1.3 1.0 1.6 0.7 1.1 -0.4 2.9 -4.2 7.9 7.0 9.2

UK 9.5 5.5 8.2 5.2 10.8 5.8 5.0 6.2 3.5 0.1 0.1 0.0

Russia 0.7 2.2 0.5 2.1 1.0 2.3 -0.9 24.5 -14.3 13.5 16.4 11.8

Brazil 0.6 0.9 0.6 1.0 0.7 0.8 9.6 15.7 3.5 7.5 7.9 7.1

India 0.4 0.8 0.3 0.7 0.4 0.9 5.1 17.3 -2.1 11.1 10.4 11.6

US 8.3 6.3 7.6 6.0 9.0 6.5 13.8 13.8 13.8 2.2 1.7 2.6

China 2.0 6.0 1.1 3.4 2.8 8.2 4.1 12.9 1.3 13.7 13.1 14.0

Asia 9.5 14.4 7.0 12.6 12.2 15.9 7.3 14.7 2.7 7.7 8.4 7.3


Total 3.0 4.1 2.0 4.4 3.6 5.1

Structure of foreign trade: Spain Countries/regions Share in total trade






EU (27) 71.3 56.1 77.8 62.8 66.3 50.2 -4.3 -1.3 -7.5 3.5 4.3 2.7

EMU (16) 59.4 44.7 61.9 49.5 57.6 40.4 -5.4 -2.7 -8.1 3.1 4.3 2.1

EMU core (BE, NL, AUS) 8.4 7.1 7.5 6.7 9.1 7.4 0.6 4.6 -2.4 4.0 5.1 3.3

Germany 14.7 10.6 13.2 10.5 15.7 10.7 -4.1 6.7 -11.8 2.8 4.2 1.8

France 18.8 13.2 19.5 16.2 18.1 10.5 -6.1 -6.2 -5.9 2.6 4.6 0.6

EMU periphery (IT, PT, IRL) 16.1 12.5 19.6 14.6 13.4 10.6 -8.7 -7.0 -10.6 3.4 3.7 3.1

Poland 0.5 1.3 0.8 1.5 0.3 1.1 -8.4 -3.7 -13.8 13.0 11.4 15.5

Turkey 0.8 1.6 1.1 2.1 0.5 1.2 -0.4 4.1 -6.5 11.6 11.2 12.1

UK 7.9 5.0 8.4 6.2 7.5 4.0 -1.6 0.9 -4.9 1.8 3.7 -0.1

Russia 0.7 2.9 0.4 1.6 0.9 4.0 -7.9 6.0 -12.0 17.6 18.4 17.4

Brazil 1.1 1.3 1.2 1.3 0.9 1.3 -0.5 9.1 -6.7 7.1 6.2 7.8

India 0.3 0.8 0.2 0.6 0.5 1.1 -2.8 -5.8 -1.3 13.4 16.7 12.3

US 5.0 3.9 4.4 4.0 5.4 3.9 1.8 14.2 -7.5 3.6 5.4 2.2

China 1.7 4.5 0.4 1.7 2.7 7.0 -2.9 11.1 -5.4 13.7 18.0 13.0

Asia 9.7 13.9 5.6 8.5 12.8 18.7 -3.4 11.9 -8.4 8.4 9.6 8.0


Total 0.2 3.8 -2.8 5.4 6.1 4.9

Structure of foreign trade: UK Countries/regions Share in total trade






EU (27) 58.5 50.4 61.1 50.2 56.3 50.5 -1.5 -5.3 1.5 4.1 3.1 4.9

EMU (17) 53.6 44.5 56.0 47.3 51.5 42.5 9.6 12.1 7.7 3.8 3.3 4.3

EMU core (BE/LUX, NL, AUS) 13.7 13.3 14.5 13.7 12.9 13.0 0.6 -1.2 2.1 5.1 4.2 5.8

Germany 13.1 12.0 12.3 10.7 13.8 12.9 1.9 -1.3 4.0 4.6 3.5 5.3

France 9.8 6.2 10.2 7.0 9.5 5.5 -3.4 -4.4 -2.5 1.6 1.7 1.5

EMU periphery (IT, ES, PT, IRL) 14.8 10.5 16.8 11.5 14.3 8.5 -7.7 -12.7 -2.9 2.5 1.6 3.5

Poland 0.5 1.5 0.7 1.1 0.3 1.8 -5.0 -20.4 4.3 14.6 8.6 20.2

Turkey 0.7 1.3 0.7 1.1 0.6 1.4 -0.6 -6.4 3.5 10.9 8.7 12.7

Russia 0.5 2.0 0.3 1.9 0.7 2.1 12.6 11.5 13.4 16.7 19.7 15.3

Brazil 0.5 0.7 0.4 0.9 0.5 0.6 -1.5 7.8 -10.0 8.9 10.5 7.4

India 0.8 1.5 0.9 1.6 0.7 1.5 -7.8 -18.1 1.9 10.8 9.5 12.0

US 22.5 12.8 24.1 15.4 21.2 10.9 -0.3 0.6 -1.2 0.8 1.1 0.5

China 1.3 6.0 0.7 3.5 1.8 7.8 3.0 13.4 0.0 18.4 18.1 18.5

Asia 5.0 9.5 3.4 5.0 6.4 12.8 -1.2 -6.7 0.5 10.6 7.9 11.6

Eastern Europe (PL, CZ, HU) 1.2 3.0 1.4 2.1 1.0 3.6 -4.5 -14.2 0.5 12.9 7.8 16.8

Total 1.2 0.3 1.8 5.3 4.7 5.8

Spain increased its trade with the rest of the EU by an annual average 3.5% during the period 1999-2012, and with the EMU states by 3.1% – compared with 13.7% in the case of China; Russia, 17.6%; Brazil, 7.1%; and India, 13.4%.

The UK increased its trade with the rest of the EU by an annual average 4.1% during the period 1999-2012, and with the EMU states by 3.8% – compared with 18.4% in the case of China; Russia, 16.7%; Brazil, 8.9%; and India, 10.8%.

Global analysis

20 www.omfif.org 20

Italy increased its trade with the rest of the EU by an annual average 3.2% during the period 1999-2012, and with the EMU states by 2.8% – compared with 13.1% in the case of China; Russia, 12.8%; Brazil, 5.2%; and India, 10.2%.

Structure of foreign trade: Italy Countries/regions Share in total trade






EU (27) 64.4 53.5 63.9 53.9 64.9 53.1 -4.0 -0.6 -7.4 3.2 3.2 3.1

EMU (16) 52.5 41.9 51.1 40.8 54.0 43.0 -4.3 -1.4 -7.1 2.8 2.9 2.7

EMU core (BE, NL, AUS) 10.5 9.3 8.0 7.2 13.0 11.5 -1.0 2.6 -3.3 3.7 3.7 3.8

Germany 18.0 13.5 16.9 12.4 19.2 14.6 -6.9 -1.1 -11.5 2.4 2.1 2.6

France 13.1 9.7 12.3 11.0 12.8 8.3 -3.5 -1.0 -6.8 2.3 3.1 1.3

EMU periphery (ES, PT, IRL) 7.4 5.7 8.6 5.7 6.3 5.6 -6.9 -7.5 -6.2 2.5 1.4 3.9

Poland 1.2 2.1 1.6 2.3 0.8 1.9 -3.5 -2.2 -5.2 9.3 7.8 11.8

Turkey 1.1 2.1 1.3 2.7 0.9 1.4 1.7 10.2 -12.1 9.9 10.7 8.6

UK 6.7 3.7 7.3 4.8 6.1 2.5 0.0 8.0 -12.8 0.0 1.3 -2.1

Russia 1.4 3.7 0.8 2.5 2.0 4.8 8.1 7.4 8.4 12.8 14.5 12.0

Brazil 1.0 1.1 1.1 1.2 0.9 0.9 -7.9 0.3 -17.3 5.2 5.4 4.9

India 0.5 0.9 0.4 0.8 0.6 1.0 -17.2 -13.6 -20.1 10.2 11.7 9.2

US 7.2 5.1 9.4 6.8 4.8 3.3 9.7 16.8 -2.8 2.0 2.0 1.8

China 1.6 4.4 0.8 2.3 2.4 6.5 -14.8 -9.9 -16.5 13.1 13.0 13.1

Asia 2.9 2.6 3.2 3.4 2.5 1.8 -0.8 10.3 -17.4 3.9 5.2 1.9


Total -1.1 3.7 -5.7 4.7 4.6 4.8

The Netherlands increased its trade with the rest of the EU by an annual average 5.7% during the period 1999-2012, and with the EMU states by 5.3% – compared with 18.4% in the case of China; Russia, 19.6%; Brazil, 10.7%; and India, 14.2%.

Structure of foreign trade: Netherlands Countries/regions Share in total trade






EU (27) 68.7 63.4 78.2 73.6 58.7 52.2 4.9 4.8 5.1 5.7 6.1 5.2

EMU (16) 55.2 48.5 65.0 57.7 44.9 38.4 3.7 4.0 3.2 5.3 5.6 4.9

EMU core (BE, AUS) 12.3 11.7 14.5 13.0 10.0 10.2 4.2 4.4 3.9 6.0 5.7 6.4

Germany 22.8 20.6 26.1 24.5 19.3 16.2 5.4 6.6 3.4 5.5 6.1 4.8

France 8.7 6.7 10.8 8.6 6.5 4.5 3.2 2.4 4.9 4.2 4.7 3.3

EMU periphery (IT, ES, PT, IRL) 9.4 7.2 11.0 8.7 9.4 5.6 2.2 0.5 5.3 4.2 4.6 3.5

Poland 0.9 2.4 1.2 2.8 0.7 1.9 -6.4 -9.0 -1.7 14.3 14.0 14.8

Turkey 0.7 1.1 0.8 1.5 0.6 0.7 -7.3 -5.0 -12.1 10.1 11.7 7.4

UK 10.3 7.7 10.8 8.2 9.7 7.1 10.7 9.1 12.8 4.0 4.3 3.6

Russia 0.7 3.4 0.6 1.7 0.8 5.3 19.4 15.3 20.9 19.6 14.9 22.2

Brazil 0.6 1.0 0.3 0.7 0.9 1.4 8.6 30.4 -0.3 10.7 13.2 9.7

India 0.4 0.9 0.3 0.5 0.5 1.4 -4.9 -13.1 -1.3 14.2 11.3 15.6

US 6.8 5.7 4.2 4.6 9.5 6.9 8.0 0.9 14.0 4.9 7.2 3.6

China 1.2 4.9 0.4 1.8 2.1 8.2 6.2 17.5 41.1 18.4 19.7 18.1

Asia 12.7 15.4 6.3 9.6 19.4 21.9 10.9 22.0 6.2 8.0 10.1 7.2


Total 6.0 5.4 6.8 6.4 6.6 6.2

this table and commentary appear by courtesy of DZ Bank, a partner and supporter of OMFIF

newsnewsStatistical forecasts

21March 2013 21

Global economy to recover in the course of 2013Politics again the focus of attention

All eyes are on Italy after the parliamentary elections. The polls have produced a stalemate with the

various political camps deadlocked. A quick and smooth coalition-building process cannot be expected. The most probable outcome is the formation of a centre-left-led government alliance with the acquiescence of former prime minister Silvio Berlusconi or the comedian-turned-vote-winner Beppo Grillo.

Yet there is a clear risk that Italy will simply descend into political chaos. And this would bring renewed fears of a scenario that had been more or less discarded in the last few months: that of a break-up of the euro area.

The new Italian government is almost certain to be weak. Most importantly, it seems unlikely that the new government will tackle the serious structural reforms needed to strengthen competitiveness and boost growth potential.

Italy’s considerable deficits in producing meaningful reforms are likely to continue to be a prominent item on the European agenda item in coming months, both at EU meetings and in the financial markets’ thinking. The problem is exacerbated by the other euro members’ sluggish progress with reforms. Above all, heavy unemployment is placing enormous social and political strains on many member states.

The economic outlook for the euro area in 2013 is subdued. The weak ending to 2012 points to another fall in economic output – this time by around 0.3%. The indicators published so far suggest that many parts of the currency area have got off to a weak start in 2013. The recession should come to an end in mid-2013, but the subsequent recovery will be weak and gradual. The lack of a second-half rebound means that the euro area will have to wait until 2014 to return to growth, when GDP is expected to rise 1.3%.

Political decisions are being taken in the US that will significantly influence the economic outlook. Since the administration failed to agree an early compromise with the Republicans in Congress, the automatic spending cuts agreed during the passage of the Budget Control Act in summer 2011 are taking effect. The so-called ‘sequester’ presents a considerable downside risk to the economy.

The Chinese economy has carried on into 2013 the recovery that began last autumn. Foreign trade has got off to a dynamic start. Monthly exports and imports have been running at an annual growth rate of more than 20%. This is the strongest growth for a year in the case of imports, and nearly two years in the case of exports. The latest manufacturing surveys confirm the growth forecast of 8 to 8.5% in the first half of 2013. y

DZ Bank economic Forecast tableGDP growth

2011 2012 2013 2014US 1.8 2.2 2.0 3.0Japan -0.5 1.9 1.5 1.6China 9.3 7.8 8.5 8.7Euro area 1.5 -0.5 -0.3 1.3Germany 3.0 0.7 0.4 2.2France 1.7 0.0 0.2 1.0Italy 0.6 -2.2 -0.9 0.7Spain 0.4 -1.4 -1.9 0.9UK 0.9 0.2 0.4 1.4

AddendumAsia excl. Japan 7.4 6.1 6.8 7.3World 3.7 3.0 3.2 3.9

Consumer prices (% y/y)US 3.2 2.1 2.7 3.0Japan -0.3 0.0 0.2 1.5China 5.4 2.7 3.0 4.0Euro area 2.7 2.5 2.5 2.5Germany 2.5 2.1 2.1 2.6France 2.3 2.2 2.3 2.4Italy 2.9 3.3 2.4 2.4Spain 3.1 2.5 3.5 2.5UK 4.5 2.8 2.4 2.7

Current account balance (% of GDP)US -3.1 -3.2 -3.1 -3.2Japan 2.0 1.0 1.1 1.5China 2.8 2.6 2.4 2.1Euro area 0.0 0.2 0.2 0.5Germany 5.7 6.2 5.6 5.0France -2.0 -2.3 -2.2 -2.0Italy -3.3 -1.5 -0.8 -0.5Spain -3.5 -2.7 -1.6 -0.2UK -1.4 -3.0 -2.5 -1.8

Produced in association with DZ Bank group, a partner and supporter of OMFIF

World monetary system

22 www.omfif.org

Worldwide flow of funds data indicate an approaching period of dollar strength, at a time when private sector holdings of dollars are relatively low. Given the dollar’s

widespread use as a major investment currency and as the main funding currency, this could spell volatility.

It is worth noting that past spikes in the net dollar liquidity measure and associated dollar strength have often coincided with financial crises The ultimate cause of financial crises is an interruption in the supply of liquidity, notably dollar liquidity. We have a de facto global currency, but no global central bank The Federal Reserve is the monopoly supplier of dollars.

World banks need dollar funding and only US banks are allowed near the Fed’s discount window. The greenback is easily the major funding currency worldwide. Latest data show that world investors are betting significantly against the dollar. Chart 1 shows variations in the world private sector financial assets held in dollar-denominated instruments. Taking out the spike in the aftermath of the 2008 Lehman Crisis, investors’ exposure to the dollar appears to fluctuate in 5-6 year cycles and currently is near a low point. The fading importance of the US economy may explain why investors shun the greenback, but it also presents a paradox. The US economy accounted for more than 40% of world GDP 50 years ago, but now musters barely 20%, with China and India, among others, muscling forward.

However, in the 1960s the dollar accounted for roughly 50% of world economic and financial transactions, whereas today the figure is as high as 70%.

Liquidity index near low while demand may rise Michael Howell, Crossborder Capital

Dark hints from dollar dance

In the 1960s the dollar accounted for roughly 50% of world economic and financial transactions, whereas today the figure is as high as 70%.

Chart 1: Investor exposure to US dollar assets, 1983-2013 (standard deviations from a rolling 3-year mean)

Source: CrossBorder Capital

news

23March 2013

More quantitative easing will drag the dollar downwards by increasing its supply, but offsetting this is the accumulation of cash flow across the US corporate and household sectors which tend to increase dollar demand.

The dollar accounts for around 85% of all foreign exchange transactions and nearly two-thirds of official foreign exchange reserves. Securities markets are largely denominated in dollars. The greenback is the dominant funding currency for international banks. Roughly two-thirds of cross-border liabilities of non-US banks, when not in their home currency, are denominated in dollars.

A dollar-based credit system requires a stable and adequate reserve base. These reserves can be supplied only by the Federal Reserve.

In another twist, they can enter world markets only through a US current account deficit and after the domestic needs of American business have been met. A warning sign of these growing illiquidity troubles is the ever more frequent use of US dollar swap lines by the Fed to get greenbacks into the hands of hard-pressed international banks. This makes the international economic system increasingly leveraged as more credit is advanced on top of this narrow reserve base. Examination of US flow of funds data shows that trouble may be brewing. A net measure of liquidity can be calculated from data on US private sector savings less Federal Reserve credit.

Chart 2 plots the net dollar liquidity measure against the annual change in the trade-weighted dollar, lagged six months.

Plainly, more quantitative easing will drag the dollar downwards by increasing its supply, but offsetting this is the accumulation of cash flow across the US corporate and household sectors which tend to increase dollar demand.

Periods when private savings exceed the index of Fed liquidity coincide with subsequent US dollar strength. y

Sources: CrossBorder Capital, US Federal Reserve, Bank of England

US Savings vs. Fed Liquidity (Adv 6m; LHS) Trade-weighted US$ Index (YoY %.Chg; RHS)

Chart 2: Net US dollar liquidity index (private sector savings less Fed credit) and annual change in trade-weighted US dollar index (lagged six months), 1980-2013

OMFIF Advisory Board

24 www.omfif.org

AD

VIS

ORY

BO

ARD

Meghnad DesaiChairman

Frank ScheidigDeputy Chairman

Songzuo XiangDeputy Chairman

John NugéeDeputy Chairman

Gabriel SteinChief Economic Adviser

Darrell Delamaide Jonathan Fenby Stewart Fleming Nick Bray

Harold James Roel Janssen William Keegan Joel KibazoHaihong Gao

Peter Bruce

EDIT

ORI

AL

& C

OM

MEN

TARY

Peter Norman

Ila Patnaik Michael StürmerJohn Plender Robin Poynder

Paul Betts

David White

Paola Subacchi Deputy Chairman

Lifen Zhang

Sushil Wadhwani Jack Wigglesworth

John CumminsStefano Carcascio Frederick Hopson

Matthew Hurn Mumtaz Khan

Hendrik du Toit

CA

PITA

L M

ARK

ETS

George Milling-Stanley Paul Newton Saker Nusseibeh

Marina Shargorodska

Trevor GreethamHon Cheung

Paul Wilson

Bruce Packard

JC Bastos de Morais

Colin Robertson

news

25March 2013

Nick Butler

Rakesh MohanAshley Eva Millar Danny Quah Abdul Rahman

EDU

CAT

ION

Meghnad Desai*Jon Davis

Steve Hanke John Hughes

Richard Roberts

Michael BurdaIain Begg

Paul van Seters Niels Thygesen

Makoto Utsumi

Shumpei Takemori Linda Yueh

Gottfried von Bismarck

Frank Scheidig**

Mario Blejer YY Chin

Dick Harryvan Carl Holsters

BAN

KIN

G

David Kihangire Philippe Lagayette

Oscar LewisohnAndrew Large

Jens Thomsen

John Adams

Ernst Welteke Derek Wong

Wilhelm Nölling

Aslihan Gedik

Consuelo Brooke

Athanasios Orphanides Francesco Papadia

Takuji Tanaka

Moorad Choudhry Jai Arya

Stefan Georg

OMFIF Advisory Board

26 www.omfif.org

John Chown

PUB

LIC

POLI

CY

Frits Bolkestein Laurens Jan Brinkhorst Shiyin Cai Neil Courtis Natalie Dempster

Vladimir Dlouhy

John Kornblum

Paul JudgeWillem van Hasselt Akinari HoriiPeter Heap

Luiz Eduardo Melin Philip Middleton John Nugée** David Owen

Christopher TugendhatMartin Raven

Poul Nyrup Rasmussen

Janusz Reiter Jorge Vasconcelos

Norman Lamont Ruud LubbersThomas Laryea

Denis MacShane

Jukka Pihlman

Kishore MahbubaniBo Lundgren

Ray Kinsella

Notes on contributorsPatrick Honohan is Governor of the Central Bank of Ireland.

Moorad Choudhry is Acting Head of Strategy and Regulation at RBS Group Treasury.

Trevor Greetham is Asset Allocation Director at Fidelity Investments International.

Michael Howell is Managing Director of CrossBorder Capital.

Michael Holstein is Head of Macroeconomics at DZ Bank.

Bruce Stokes is Director of Global Economic Attitudes at the Pew Research Center.

Philippe de Schoutheete is former Belgian Permanent Representative to the European Union.

news

27March 2013

Robert Bischof

Hemraz Jankee Pawel Kowalewski

Isabel MirandaMariela Mendez

Paola Subacchi**

Gerard Lyons

Peter Walton John West

Vilem Semerak

RESE

ARC

H &

ECO

MO

MIC

S

Katinka Barysch Paul Boyle

Albert Bressand Stephane Deo

Michael Oliver

David Tonge Songzuo Xiang**

Hans-Olaf Henkel

MA Del Tedesco Lins

Gabriel Stein**

Anthony Robinson

Song Shanshan

2013 diary dates

Economists Club Meeting: Poland’s views on Europe and the world economy

Marek Belka, President, National Bank of Poland27 March, National Bank of Poland,

Warsaw, Poland

Lecture with Prof. Songzuo Xiang, Chief Economist, Agricultural Bank of China

24 April, London

Economists Club Meeting: Economic conditions in Belgium and the euro area

25 April, National Bank of Belgium, Brussels, Belgium

ASEAN + 3 reserve asset management seminarDr. Darmin Nasution, Governor, Bank Indonesia

25 April, London

Second Bank of Japan seminarShigeto Nagai, General Manager for Europe and

Chief Representative, Bank of Japan1 May, London

Lecture with Jaime Caruana, General Manager, Bank for International Settlements

16 May, London

Lecture with James Bullard, President, Federal Reserve Bank of St. Louis

23 May, London

Lecture with Prof. Charlie Bean, Deputy Governor, Bank of England29 May, London

First OMFIF Meeting in Latin America17-18 June, Banco Central do Brasil Brasilia, Brazil

Fourth OMFIF Main Meeting in Europe5-6 September, Central Bank of Turkey,

Ankara, Turkey

Third Asian Central Banks’ Watchers Group Annual Meeting

28 October, Bank of Korea, Seoul, South Korea

Newsthe Keegan commentary

28 www.omfif.org

A regular round-up on international monetary affairs

There is no getting away from it. Governments may laugh off poor

results in by-elections, but the result of the February Eastleigh by-election in southern England was very bad for the Conservative Party in general and the Prime Minister and Chancellor in particular.

I am referring, of course, to our old friends David Cameron and George Osborne.

There were many factors behind the way the Conservatives were driven into third place by their junior coalition partner, the Liberal Democrats, and its rival for the right wing vote, the rather sinister faction known as UKIP (United Kingdom Independence Party).

Cameron’s ultra-right wing opponents were immediately baying for his blood. But the PM knows only too well that the tactic of moving to the right and becoming even more eurosceptic didn’t help a string of his Conservative party predecessors when New Labour was in office from 1997 onwards.

But, to use a phrase that the PM has made famous, Cameron and his chancellor Osborne ‘are in this together’. Quite apart from the centre-right versus extreme-right debate on social issues, immigration and ‘Europe’, there is the cliché in the room known as the present government’s economic strategy.

To my mind it was obvious at the time – May 2010 – that Osborne ‘called it wrong’ in staking so much on deficit reduction at a time of, let’s face it, depression, and on making the preservation of the UK’s triple A credit rating the criterion, for the financial markets, of his success.

It was also obvious to Labour’s Ed Balls. At the time, he had not been made shadow chancellor. But in August 2010, in a speech at Bloomberg’s London HQ, Balls delivered a brilliant analysis of the UK’s economic problems, and a terrifyingly accurate prediction of the likely consequences of the new government’s decision to put deficit reduction above growth.

Even Osborne’s most gullible supporters must now realise that, in the immortal words of the great American novelist Joseph Heller, ‘Something Happened’.

Plan A, as it is known, has not worked. But Osborne cannot admit to himself or anyone else that it has not. And so he dismisses all suggestions of the need for a ‘Plan B’.

Instead, the British public has been treated to a variety of inchoate announcements about various infrastructure and other initiatives. At the same time, encouraged by the chancellor, the Bank of England scrapes the bottom of the barrel marked ‘possible monetary initiatives’. Yet it knows in its heart of hearts that, as Keynes said many years ago, there are times when monetary policy is about as efficacious as pushing on a string.

The only way out of the present UK policy impasse is for a U-turn, in which, at the temporary expense of higher borrowing in the short term, a massive fiscal expansion is engineered. This is what Keynes taught in the 1930s, and this is what is needed now.

The key question is: can the present prime minister and chancellor do this? Certainly it is difficult to envisage a change of heart from Osborne.

Cameron is said to admire Harold Macmillan, who, having been chancellor himself for just over a year up to 1957, was ruthless about sacking, or encouraging to resign, chancellors who were not up to it. During Macmillan’s six and three quarter years as prime minister (1957-63), there were no fewer than four chancellors. Their names, just in case Osborne wishes to remember them, are: Peter Thorneycroft (1957-

58), Derick Heathcoat-Amory (1958-60), Selwyn Lloyd (1960-62), Reginald Maudling (1962-64), who stayed on after Macmillan’s departure.

Mrs Thatcher did not get on with Sir Geoffrey Howe

(Chancellor 1979-83) and moved him to the Foreign Office after the 1983 election. She and Nigel Lawson (Chancellor 1983-89) fell out over exchange rate policy and the ERM, and Lawson resigned.

His successor John Major became prime minister after a year at the Treasury, when the Conservative Party effectively sacked Thatcher, who had previously been their heroine. Then, at a decent interval after the Black Wednesday fiasco when the UK left the ERM in September 1992, Major sacked Chancellor Norman Lamont in spring 1993.

These are turbulent times. The positions of both Osborne and Cameron could be vulnerable. Who is most at risk? The Conservative party’s history, outlined above, shows that Osborne, some time before the next election in 2015, could be sacrificed. y

Osborne may face fate of Macmillan’s finance ministersuK needs borrowing u-turn

William Keegan, Chairman, Board of Contributing Editors

Cameron is said to admire Harold Macmillan, who, having been chancellor

himself for just over a year up to 1957, was ruthless about sacking, or encouraging to resign, chancellors who were not up to it.

Documents

Meghnad Desai, Chairman, Advisory Board · to what Greece went through last year with its dual elections. Greece rejected holding a referendum on the euro, and ended up electing a